Wednesday, June 18, 2008

Yes, of course I read some of the increasing number of articles claiming that the US will avoid a recession. I just don’t care anymore. It makes me tired. I don't want to talk about it any longer, it's enough. None of those claims have any foundation in the real world. It’s all stuck between illusion and delusion, economics as a religion, people believing what they want to believe. While they should be preparing for what’s to come, people instead opt to chase unicorns and white crows.

How about this for a lone word of wisdom: "... economist Christopher Thornberg of Beacon Economics thinks home values must fall even lower to come in line with what people can afford to pay."

Mortgage requirements will inevitably be tightening fast, and people will have to put ever more money down to purchase a house. But personal savings in the US are actually negative. So what will people be able to afford to pay? Next to nothing at all, that’s what. And that is what will determine home values.

Also, please note that the first article today states almost to the letter what Stoneleigh and I have been saying for a very long time. Perhaps the world is waking up.....

The Royal Bank of Scotland has advised clients to brace for a full-fledged crash in global stock and credit markets over the next three months as inflation paralyses the major central banks. "A very nasty period is soon to be upon us - be prepared," said Bob Janjuah, the bank's credit strategist.

A report by the bank's research team warns that the S&P 500 index of Wall Street equities is likely to fall by more than 300 points to around 1050 by September as "all the chickens come home to roost" from the excesses of the global boom, with contagion spreading across Europe and emerging markets. Such a slide on world bourses would amount to one of the worst bear markets over the last century.

RBS said the iTraxx index of high-grade corporate bonds could soar to 130/150 while the "Crossover" index of lower grade corporate bonds could reach 650/700 in a renewed bout of panic on the debt markets. "I do not think I can be much blunter. If you have to be in credit, focus on quality, short durations, non-cyclical defensive names.

"Cash is the key safe haven. This is about not losing your money, and not losing your job," said Mr Janjuah, who became a City star after his grim warnings last year about the credit crisis proved all too accurate. RBS expects Wall Street to rally a little further into early July before short-lived momentum from America's fiscal boost begins to fizzle out, and the delayed effects of the oil spike inflict their damage.

"Globalisation was always going to risk putting G7 bankers into a dangerous corner at some point. We have got to that point," he said. US Federal Reserve and the European Central Bank both face a Hobson's choice as workers start to lose their jobs in earnest and lenders cut off credit.

The authorities cannot respond with easy money because oil and food costs continue to push headline inflation to levels that are unsettling the markets. "The ugly spoiler is that we may need to see much lower global growth in order to get lower inflation," he said.

"The Fed is in panic mode. The massive credibility chasms down which the Fed and maybe even the ECB will plummet when they fail to hike rates in the face of higher inflation will combine to give us a big sell-off in risky assets," he said.

Kit Jukes, RBS's head of debt markets, said Europe would not be immune. "Economic weakness is spreading and the latest data on consumer demand and confidence are dire. The ECB is hell-bent on raising rates. "The political fall-out could be substantial as finance ministers from the weaker economies rail at the ECB.

Wider spreads between the German Bunds and peripheral markets seem assured," he said. Ultimately, the bank expects the oil price spike to subside as the more powerful force of debt deflation takes hold next year.

Morgan Stanley, the second-biggest U.S. securities firm, said profit dropped 57 percent, in line with analysts' estimates, on declines in trading, asset management and investment banking.

Earnings from continuing operations fell to $1.03 billion, or 95 cents a share, in the second quarter from $2.36 billion, or $2.24, a year earlier, the New York-based firm said today in a statement. The average estimate of 19 analysts surveyed by Bloomberg was for earnings of 92 cents a share.

Chief Executive Officer John Mack wasn't able to rely on stock traders and money managers to offset writedowns of bonds backed by real estate and leveraged loans. He sold a Spanish wealth management business and part of the firm's stake in equity index provider MSCI Inc. to bolster revenue. Lehman Brothers Holdings Inc. reported its first loss in 14 years as a public company earlier this week and Goldman Sachs Group Inc. said yesterday that earnings fell for a second straight quarter.

"We look at the 95 cents as really somewhat of a low- quality beat to the consensus" of estimates, Roger Freeman, an analyst at Lehman Brothers, who has an "equal weight" rating on the stock, said in a Bloomberg Radio interview. The firm's "core earnings" amount to "a miss rather than a beat."

Morgan Stanley's net income fell to $1.03 billion, or 95 cents a share, from $2.58 billion, or $2.45, a year ago. Revenue fell 38 percent to $6.51 billion in the three months ended May 30 and the firm's annualized return on equity, a measure of how well shareholders' money is reinvested, declined to 12.3 percent from 29.4 percent a year ago. That compares with Goldman's second-quarter return on equity of 20.4 percent.

Colm Kelleher, Morgan Stanley's chief financial officer, said in an interview today the firm has suspended a credit trader in London for incorrectly valuing his positions. The firm said it made a $120 million "negative adjustment" related to the trades after discovering the error in May.

Banks and brokers have taken more than $392 billion of writedowns and credit losses since the beginning of last year as mortgage-backed securities, collateralized debt obligations, leveraged loans and other fixed-income assets dropped in value. Morgan Stanley reported its first loss as a public company in December after $9.4 billion of writedowns on mortgage-related investments.

Morgan Stanley, led by the 63-year-old Mack, announced plans last month to reduce its headcount by as much as 5 percent. The company has eliminated at least 3,000 jobs since October.

Ilargi: No, don’t worry, JPMorgan doesn’t decide to come clean; once Bear’s toxic assets come out of the closet, they’ll be back at the Fed, who will call on the Treasury, who will dole out more of your money. The Bulgaria model has been proven to work. Well, not for you, but then, you are not the protagonist, or even the tragic hero, in this story.

JPMorgan Chase’s top investment banking executives conceded yesterday that their acquisition of Bear Stearns was worth far more than the rock-bottom $10 a share price they paid, but that the market turmoil is still taking a toll on investment-banking profits and may result in further layoffs, CNBC has learned.

The executives—CEO Jamie Dimon, as well as investment banking co-heads Steve Black and Bill Winters—made the comments late yesterday afternoon during their first company address to the newly combined investment bank. JPMorgan acquired Bear Stearns in mid-March, first offering a paltry $2-a-share price before later upping their bid to a still-low $10 a share.

The meeting was held in JPMorgan’s large cafeteria, attended by about 1,000 employees. Executives with the firm estimate that another 2,000 employees called in to hear the widely anticipated talk. Bear was forced to sell itself to JPMorgan amid a run on the bank that nearly toppled the US financial markets as investors bet that bad loans on Bear’s books would leave the firm insolvent.

Under the terms of the deal, the Federal Reserve guaranteed $30 billion of those bad loans, while JPMorgan agreed to assume the first $1 billion. That said, Black, the investment banking co-chief, said the integration of the firm is proceeding "smoothly" and that JP Morgan "got something that has far more value then the price we paid," according to people who attended.

Black said JPMorgan expects to earn an additional $1.1 billion in 2009 from the Bear Stearns businesses. Dimon later stated that the firm still hasn’t come up with just how much of the first $1 billion in liabilities JPMorgan will have to shell out.

Despite some positive talk on the Bear merger, the executives were quick to point out that business conditions on Wall Street remain glum. JPMorgan has withstood the impact of sub-prime collapse better than most firms, but like its Wall Street counterparts, profits have been hammered so far this year in the investment banking business

Ilargi: To all out there who still think the central banks are printing money like mad, or even that this could make up for vanishing credit, read carefully: "The Money Supply is Plummeting".

Britain's lonely band of monetarists fear that the Bank of England will trigger a severe crunch if it overreacts to the inflation spike and keeps interest rates too high as the downturn gathers pace. An abstruse and little-understood measure of the money supply - "adjusted M4" - is flashing serious warning signals of distress over coming months, replicating a pattern that led to a vicious slump in the early 1980s.

Simon Ward, New Star's chief economist, says the growth rate of M4 holdings of corporations (excluding banks) has plummeted from 16.1pc a year ago to 1pc in April. Past falls of this kind have heralded economic contraction. It is the speed of the decline that matters most, rather than the absolute level.

"This slowdown is contributing to a dangerous liquidity squeeze on companies. We're not in a recession yet, but it is approaching rapidly," he said. "It would be disastrous if the Monetary Policy Committee tried to over-compensate for their errors in 2006 and 2007 by tightening too hard now," he said. The M4 money data - which includes a wide range of bank accounts as well as cash - often gives advance warning of major shifts in the economy.

Leading monetarists such as Professor Tim Congdon from the London School of Economics warned three years ago that surging M4 growth would lead to a property bubble and inflation. This is exactly what occurred, although a surge in global food and oil prices have been a crucial factor. Mr Congdon say the risk has now inverted as the credit crisis eats into bank lending.

"The money supply is plummeting. This is potentially serious," he said. The warnings come amid a flurry of gloomy reports from City banks. Lehman Brothers warned that UK house prices would fall 28pc from peak to trough, the grimmest forecast to date. BNP Paribas said the UK faced a "significant risk" of a deep and protracted recession.

The Bank of England says the overall M4 figure - growing at 11.1pc - is distorted by strains in the interbank markets. Once this effect is stripped out, the M4 growth rate is down 16pc a year ago to 4.5pc in the first quarter. The money markets have already begun to price in two to three rate rises this year, so some degree of tightening is already happening.

"A rate rise is out of the question. The Bank may soon need to start cutting," said Mr Ward. The Bank's Governor, Mervyn King, pays close attention to M4 data. This might explain why he has played down the surge in inflation to 3.3pc in May, the highest since the Labour era began. Mr King's letter to the Chancellor, Alistair Darling, stressed that the commodity spike was "not the same as continuing inflation" and that there was no sign of a broad-based jump in wages.

"In recent months the growth rate of the broad money supply has eased and credit conditions have tightened. This will restrain the growth of money spending in the future," he wrote. It is less clear whether the MPC fully agrees with him. Economists are deeply split over the balance of risks in the world as the commodity boom and imported inflation from the emerging world collide with an economic downturn in the West.

Hawks fear that Britain is on the cusp of a 1970s wage price spiral: doves fear a deflationary crunch that may lie beyond as the triple effects of the lending squeeze, the housing slump, and the global slowdown all combine to send prices into a sharp fall.

Ilargi: And if the money supply is plummeting, you can of course not have stagflation, no matter what whoever says.

The U.S. economy may be suffering from its first bout of stagflation since the start of this decade, reports on housing, prices and manufacturing indicated.

Builders broke ground on 975,000 homes at an annual pace in May, the least in 17 years, and construction permits fell, the Commerce Department reported in Washington. Meanwhile, the Labor Department said producer prices jumped 1.4 percent, more than economists forecast. A further report from the Federal Reserve showed industrial production unexpectedly dropped 0.2 percent.

"The latest round of commodity-price pressure is adding to both inflation and weak growth," said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc. in New York. "It's a pretty negative cocktail for the economy and financial markets." The reports underscore the Fed's dilemma as officials try to prepare investors for an interest-rate increase. Too strong a crackdown on inflation may delay an economic rebound, while waiting too long risks a price outbreak that may need even higher borrowing costs to tame.

"We should be moving sooner rather than later," William Poole, a former president of the St. Louis Fed, said in an interview today with Bloomberg Television in New York. "I don't think you can interpret what's happening with energy as a temporary shock."

"Industrial production is down, that's the stag part, and prices are up, that's the inflation part," said Neal Soss, chief economist at Credit Suisse Holdings Inc. in New York. Compared with the 1970s, though, "it's not likely that inflation will get as out of control when wages do not respond."

The producer-price index jump exceeded the 1 percent forecast among economists surveyed by Bloomberg News. It was the biggest increase since November. The Labor Department's figures also showed that prices rose 0.2 percent excluding food and energy, a measure that matched economists' predictions. Production was expected to increase 0.1 percent.

"This period of stagflation is lasting longer than expected," said Harris. "It's not to say that we are back in a 1970s-type situation. We have a much more credible central bank," no wage and price controls and "the labor markets are behaving well."

Ilargi: Due diligence? After paying $24 billion for a barrel of snakes, they now call new borrowers to warn them? Man, that’s a lame line.

I very much doubt Wachovia will exist this time next year. $24 billion for a lender that has $120 billion in bad ARM’s is Russian roulette. Moreover, Wachovia is the only bank still making these loans, and mostly in California to boot. Double or nothing......

Wachovia Corp., which ousted its top executive after estimating it may lose more than $4.5 billion on adjustable-rate home loans, will start calling would-be borrowers to explain the risks of such mortgages.

Wachovia is contacting applicants through independent mortgage brokers to ensure "the customer understands the key features of the Pick-A-Payment loan product," according to a June 11 memo from Tim Wilson, head of loan origination at the Charlotte, North Carolina-based company. The loans let borrowers defer part of their monthly bills.

Wachovia and lenders including Countrywide Financial Corp. and Washington Mutual Inc. have been burned by delinquent option adjustable-rate mortgages, often called option-ARMs. Wachovia is led by interim Chief Executive Officer Lanty Smith who replaced Kennedy Thompson on June 2, two years after the bank's $24 billion purchase of Golden West Financial Corp. at the peak of the housing boom.

"Stepping so much into the underwriting process is very unusual and almost unprecedented," said consultant David Lykken of Mortgage Banking Solutions in Austin, Texas. "My sense is that to appease the federal regulators they are saying we will do this extra kind of due diligence." Wachovia spokesman Don Vecchiarello confirmed the new policy, which took effect this week.

Golden West was the market leader in option-ARM mortgages, with about $120 billion of the loans when it was acquired by Wachovia. The loans, termed Pick-a-Payment by Wachovia, allow borrowers to make lower initial payments that don't even cover the accrued interest. Almost 70 percent of Wachovia's borrowers choose to pay as little as possible.

The unpaid portion gets added to the principal of the loan. That can backfire on the bank if a borrower defaults while home prices are falling, leaving the lender unable to recover the full amount owed. U.S. single-family home prices fell at a 6.7 percent annualized rate in the first quarter, Waltham, Massachusetts- based research firm Global Insight Inc. said June 2.

Originations of option-ARMs fell more than 50 percent last year after making up 8.9 percent of the almost $3 trillion in U.S. home loans made in 2006, according to estimates by industry newsletter Inside Mortgage Finance. Delinquencies are rising as interest rates tied to the loans increase, forcing borrowers to make larger payments. Once option-ARM borrowers' loan balances reach a predetermined limit of 125 percent of the mortgage amount, Wachovia requires higher payment rates.

You have got to be kidding me. While Pay Options are a lead anchor around the neck of every bank who ever touched them, Wachovia continues to insist that theirs are different. If you remember, for months they ran Pay Option commercials with families dancing around their houses, singing, because they could pay the minimum monthly payment if they want to. I found that insulting and absolutely ignorant on their part.

Now, Wachovia is calling broker-originated borrowers, making sure they understand what they got themselves into. Don’t ya love how they still try to blame it on the mortgage broker. Hey Wachovia, this is your loan program, not the brokers!

Many borrowers may understand, but few will have a good enough grasp on the loan to understand how it WILL perform under various market or economic scenarios or stresses, if underlying index values soar or if values plummet, as they are now. This loan was never meant to hold for any period of time and absolutely never meant to hold in a period of declining house prices.

While the Pay Option ARM maybe a perfect loan for someone such as an investor with a large amount of equity in a property who is waiting for the purchase market to improve before selling and wants to cash-flow, my guess is that 90% of Pay Option borrrowers are in it because they only could afford the home by paying the minimum monthly, negatively amortizing payment. These loans are the ultimate toxins, even more so than subprime 2/28’s. At least with subprime loans, the principal balanced owed doesn’t grow every month.

"Wachovia is contacting applicants through independent mortgage brokers to ensure “the customer understands the key features of the Pick-A-Payment loan product,” according to a June 11 memo from Tim Wilson, head of loan origination at the Charlotte, North Carolina-based company. The loans let borrowers defer part of their monthly bills."

Wachovia’s clients fall in line with other published numbers with 70% of borrowers choosing to make the minimum monthly payment. Below is a graphic showing an recently update recast schedule for Pay Option ARMs. This is a disaster that will surely keep the foreclosure issue on the front pages for a long time.

"Golden West was the market leader in option-ARM mortgages, with about $120 billion of the loans when it was acquired by Wachovia. The loans, termed Pick-a-Payment by Wachovia, allow borrowers to make lower initial payments that don’t even cover the accrued interest. Almost 70 percent of Wachovia’s borrowers choose to pay as little as possible. "

The truth is Wachovia’s Pay Options are different and in my opinion, probably worse. The primary differences are that they did not do 100% loans in any size and they did a good job validating appraisals by a variety of means. As a matter of fact, over the years World/Golden West/Wachovia has been known to be ‘tough on appraisals’ meaning they always tried to cut the value. In the risk-management game, this is a good thing for the bank.

But, with values down in CA on the median by 28% in the past 11-months and much further in many areas, not doing 100% loans doesn’t really matter too much. Borrowers across the state are sitting in massive negative-equity positions and once you get upside down, does it really matter if you are upside down by 20%, 30% or 50%?

Once the borrower gets a hard-recast letter saying “you have reached your maximum allowable negative amortization for this loan program, so now you must either a) refinance b) pay a minimum of interest only payments so as not to accrue any more negative amortization (this could double the payment)”, borrowers default.

First, you can’t refi in most cases. Second, why in the world would you want to pay twice the monthly payment for a home that has dropped 30% in value and in which you have accrued 15 to 25% negative amortization depending on the lender? By the time they get this letter, a borrower could be upside down 50%!

Ilargi: And here’s another "isolated incident". What would you think the odds for survival are for all those banks that have lost 60-70% of their share value over the past year?

Charge-offs in 2009 will be higher than the expected 1.6 percent to 1.65 percent of total loans this year, and the lender anticipates "continued growth" in loan loss reserves, the Cincinnati-based bank said in a regulatory filing today. The quarterly dividend was slashed 66 percent to 15 cents a share.

U.S. banks may need to raise another $65 billion in capital as losses and writedowns tied to the U.S. housing slump extend into the first quarter of 2009, Goldman Sachs Group Inc. analysts said in a note yesterday. Fifth Third's first-quarter profit fell 19 percent as the bank increased loan and lease loss provisions by more than sixfold.

The bank lowered the dividend "in light of our expected levels of earnings over the near-term and the benefits of building capital at a higher pace during this part of the current credit and economic cycles," Chief Executive Officer Kevin Kabat said in a statement. Kabat is taking over the chairman's duties for the company, Fifth Third said.

The bank dropped $1.68 to $11.05 at 7:58 a.m. before the open of regular trading in New York. The lender has plunged 70 percent over 12 months in Nasdaq Stock Market trading. Fifth Third said the funds would raise its Tier 1 capital ratio to 8.5 percent, above the regulatory minimums. The new estimate doesn't include a potential $250 million charge the lender might be forced to take as a result of losing a tax case tied to how the company accounted for leasing transactions.

Fifth Third joins the list of banks and securities that have raised more than $300 billion to shore up their balance sheets after losses tied to mortgage and debt markets. Kabat said at a conference May 12 that the company had "taken steps" to make loans to "the right people," and that it might take time for the results to become apparent.

"We haven't had the need, we don't foresee the need, to resort to any kind of significant common equity raise which we've seen a few in the industry need to do recently," Kabat said then.

Ilargi: And still, the "worst" predictions say that UK home prices will fall 10-25%, with Lehman’s the "grimmest" at 28% peak to trough. I don’t mind stating once more that it will be 80% or more; we simply have to wait a while for the "experts" to catch up with reality.

And what is so hard to grasp here? UK housing prices rose over 200% in the past decade. So if they started at 100%, they are now at more than 300%. They first have to fall back to the trendline, but will do so with a downward swing. Ergo, over 66.7% to get to the trend, and a nice oscillation move to top it off.

I don’t even see how anyone can claim a 25% drop would be all. That makes no sense whatsoever.

Remarkable, isn't it, how industries that complain about Government interference during boom times are quick to scream for state aid when the going gets tough. First it was the bankers, poor darlings, who demanded help, now housebuilders are calling on ministers to "do something".

The typical plea, you might have noticed, is rarely a straightforward appeal for taxpayers' money to rescue badly run companies. That would seem too much like charity. Instead, requests for handouts are dressed up as being "in the national interest" and necessary to avoid "systemic failure".

Earlier this week, John Slaughter, a director of the Home Builders Federation, told me in an interview on Sky that 25,000-30,000 construction jobs would go if the current situation continued. "We are saying very strongly to Government, 'You need to take good account of this and try to help the market at the moment so we don't lose too much capacity'," he said.

Far from being as safe as houses, this is an industry that cannot take even a few months of downturn, albeit a sharp one. Having enjoyed the toro bravo of bull markets, with year after year of record profits, some of its biggest players are already passing round the hat for emergency funding.

How come? What happened to the insulation against a cold snap? For a decade and a half, Britain's residential property sector was a one-way bet for builders, developers and estate agents. As house prices went to the moon, those in the bricks and mortar business felt they had discovered a permanent home in the sun. The only shadow on prosperity, it seemed, was cast by pesky officials in charge of planning consent.

Never mind that more and more buyers, particularly first-timers, were having to perform financial gymnastics to clear the mortgage bar, the housebuilding industry was happy to believe in eternal summers. Warnings that borrowers would crack under the weight of their debts went largely unheeded. Barratt Developments, Britain's most prolific builder, enjoyed 14 consecutive years of rising profits, as it pushed operating margins above 16pc.

Only last year, its chairman, Charles Toner, told investors: "We have strengthened our landbank and have achieved a record forward sales position… the housing market is sound and the underlying business is strong." As forecasts go, that ranks alongside BBC weatherman Michael Fish's confident comment in October 1987 that we were not to worry because there was no hurricane on the way - a day before Britain's roof was blown off.

Chief executive Mark Clare was so thrilled with Barratt's prospects that in February 2007 he bought rival Wilson Bowden for £2.2bn. At the time, Clare had been in the job only a few months and had little experience of housebuilding. By contrast, David Wilson, who founded Wilson Bowden, had spent a lifetime in the industry. The timing of his exit, even though he took only about half his payment in cash, looks exquisite.

Equally clever was the decision of Jon Hunt, the founder of Foxtons, to sell his posh estate agency last July, the peak of the market, for £390m. Had Hunt waited 12 months, he would not have got even a quarter of that price. In fact, as the housing market crumbles, many agencies are simply unsaleable.

Trevor Kent, an estate agency veteran, reckons that at least 1,000 offices have closed across the country in the past three or four months, with another couple of thousand in line for the chop. He sees no quick fix. "I think house prices will go down 10pc in the next 12 months," he said. "We could be talking three years at least before we get a normal market again."

Others are gloomier still. Lehman Brothers calculates that house prices could fall by more than 25pc from their peak, leaving up to 2m homeowners struggling with negative equity. Were that to be the case, the corporate casualty list would extend way beyond fringe players.

Barratt is by no means the only troubled housebuilder, share prices across the sector are down by 50pc or more, but it is the one against which the City is betting most aggressively. It has lost 90pc of its stock market worth, wiping out about £4bn of shareholder value.

Consumers could be hit by energy price rises of up to 40 per cent this year as power companies struggle to maintain profitability in the face of a trebling in wholesale gas prices. Leading market analysts said yesterday that an increase of that magnitude would drive average UK energy bills from £1,048 at present to £1,467 within seven months.

John Hall, an adviser on energy issues to industrial and corporate clients representing 15 per cent of the UK commercial gas and electricity market, said that Britain’s six major energy suppliers would need to raise prices by between 30 and 40 per cent this year to maintain margins.

Wholesale gas prices, which are linked to global oil prices, have increased nearly threefold in a year from 36.35p per therm in June last year to 94.54p yesterday. They briefly touched record highs of about 105p per therm earlier this month. Crude oil prices have also touched a record of nearly $140 a barrel this week. Mr Hall said: “Unless there is a dramatic fall in oil prices, that is the scale of increase we are talking about to ensure that energy companies keep their margins.”

Britain’s power companies are gearing up for a fresh round of price rises, the first of which could come as early as next month. Mr Hall predicted that a staggered increase, with one in the summer and another in late autumn or early winter, assuming wholesale prices remain at current levels, is likelier than a single increase, which would trigger a huge public outcry.

Peter Atherton, utilities analyst for Citigroup, agreed that power companies will need to consider price rises of 30 per cent-plus this year if they expect to maintain reasonable profit margins from retail distribution. However, he expected that the public outcry that would result from such big rises would lead companies to accept very low profits from their supply businesses this year and to balance that against higher earnings from power generation.

The warnings came yesterday as MPs accused Ofgem, the energy regulator, of being a toothless tiger that did not do enough to help consumers in the face of soaring energy prices. At a Commons committee hearing, Lindsay Hoyle, Labour MP for Chorley, made a stinging attack on Alistair Buchanan, Ofgem’s chief executive. Mr Hoyle said that energy companies blamed poor planning laws for not building enough storage facilities to enable Britain to be self-sufficient but he said that it was in the companies’ interests not to tackle the problem since they stood to benefit from passing on the higher prices to consumers.

Mr Hoyle asked Mr Buchanan whether he was prepared to act now to address the issue, adding: “Or are you the toothless tiger that we imagined?” Citigroup’s analyst thought the likeliest pricing scenario is a rise in retail prices of up to 25 per cent, which would lead to extremely thin or zero profits from retail power supply.

Ilargi: And with energy prices rising 40%, the government insists there should be no rise in paychecks. That’ll be a highly popular policy. Re-election’s in the bag.

Hundreds of thousands of public sector workers are threatening to tear up agreements and demand higher pay as the cost of living surges. Inflation figures released yesterday were worse than expected, prompting Unison, one of the biggest public sector unions, to call for the reopening of a pay deal for 500,000 health workers clinched only two weeks ago.

Other unions said that they wanted to revisit pay deals and gave warning of rolling strikes this autumn if Gordon Brown persisted in trying to cap pay rises at 2 per cent. Soaring food, fuel, gas and electricity prices sent the official inflation rate surging last month, wrong-foot-ing policymakers and forcing the Governor of the Bank of England to write to the Chancellor to explain how it had failed to keep the lid on inflation.

In an open letter to Alistair Darling, Mervyn King admitted that the consumer prices index (CPI), which measures food and fuel prices, reached 3.3 per cent in May, smashing through the upper limit of the Government’s 1 to 3 per cent target range. He blamed external factors such as the cost of crude oil and world farm prices. Mr King predicted that the CPI would rise to more than 4 per cent before the end of the year.

The retail prices index, regarded as a better measure of the cost of living because it includes mortgage interest and council tax, rose from 4.2 per cent to 4.3 per cent. Yesterday, amid signs of the Government losing its inflation-fighting credentials, Mr Brown ordered a pay freeze for all ministers and proposed a less generous deal for MPs than that suggested by an independent report. The Prime Minister said that increases would be inappropriate at “a time of economic uncertainty”.

Mr King said that it was crucial that employees should not respond to the loss of their real spending power by bidding for more substantial pay increases. The rise in living costs has not yet fed through into wage demands, but policymakers fear that if this happened it could lead to a 1970s-style prices and wages spiral.

Dave Prentis, the general secretary of Unison, said that Mr Brown would pay the “ultimate price” at the next general election if he continued to “shower insults” on public sector workers. He told the union’s annual conference that it would ballot for industrial action among its NHS members if the Government refused to reopen a deal giving 8 per cent over three years.

Unison officials said that they would revisit a clause in the deal which recognises that members need to be “protected” if inflation rises. Mike Jackson, senior health officer, said that the second and third years of the three-year deal could be renegotiated. Many public sector deals have escape clauses allowing renegotiation if circumstances materially change.

A decline in U.S. housing starts and building permits in May have economists convinced that the end is not yet near for the U.S. housing market turmoil.

"U.S. housing starts have left no doubt that the housing crunch is still in full swing," said Dimitry Fleming at ING Wholesale Banking. "Home builders have now cut production 60% since the peak early 2006, but despite these drastic measures the overhang - as measured by the months of available supply - is still enormous and is even approaching the highs of the early `80s crash." "For now, all they can do is wait for Federal help and in the meantime cut, cut, cut production," he added.

U.S. housing starts came in below expectations at 975k in May, a month-over-month decline of 3.3%, according to data released from the U.S. Department of Commerce on Tuesday morning. The consensus was looking for a decline to a 980k level. The previous month's 1032k was revised to a level of 1008k.

"Overall the report does support our view that the strong surge in starts reported last month (which has now been revised downwards substantially) was not an indication of an eminent rebound in the U.S. housing sector, and was in fact an anomaly," said Millan Mulraine, economics strategist at TD Securities. "Moreover, fundamentals in the housing sector appear to suggest that a turn-around is not likely to take place until the latter part of this year."

Ilargi: Dreams of shifting housing preferences towards walkable communities will never be anything but dreams. It is too late for America to turn around. There is no money left: 35% of the nation’s wealth is invested in the failing suburbs, and can’t be redeployed elsewhere.

While the foreclosure epidemic has left communities across the United States overrun with unoccupied houses and overgrown grass, underneath the chaos another trend is quietly emerging that, over the next several decades, could change the face of suburban American life as we know it.

This trend, according to Christopher Leinberger, an urban planning professor at the University of Michigan and visiting fellow at the Brookings Institution, stems not only from changing demographics but also from a major shift in the way an increasing number of Americans -- especially younger generations -- want to live and work. "The American dream is absolutely changing," he told CNN.

This change can be witnessed in places like Atlanta, Georgia, Detroit, Michigan, and Dallas, Texas, said Leinberger, where once rundown downtowns are being revitalized by well-educated, young professionals who have no desire to live in a detached single family home typical of a suburbia where life is often centered around long commutes and cars.

Instead, they are looking for what Leinberger calls "walkable urbanism" -- both small communities and big cities characterized by efficient mass transit systems and high density developments enabling residents to walk virtually everywhere for everything -- from home to work to restaurants to movie theaters.

The so-called New Urbanism movement emerged in the mid-90s and has been steadily gaining momentum, especially with rising energy costs, environmental concerns and health problems associated with what Leinberger calls "drivable suburbanism" -- a low-density built environment plan that emerged around the end of the World War II and has been the dominant design in the U.S. ever since. Thirty-five percent of the nation's wealth, according to Leinberger, has been invested in constructing this drivable suburban landscape.

But now, Leinberger told CNN, it appears the pendulum is beginning to swing back in favor of the type of walkable community that existed long before the advent of the once fashionable suburbs in the 1940s. He says it is being driven by generations molded by television shows like "Seinfeld" and "Friends," where city life is shown as being cool again -- a thing to flock to, rather than flee."The image of the city was once something to be left behind," said Leinberger.

Changing demographics are also fueling new demands as the number of households with children continues to decline. By the end of the next decade, the number of single-person households in the United States will almost equal those with kids, Leinberger said.And aging baby boomers are looking for a more urban lifestyle as they downsize from large homes in the suburbs to more compact town houses in more densely built locations.

Recent market research indicates that up to 40 percent of households surveyed in selected metropolitan areas want to live in walkable urban areas, said Leinberger. The desire is also substantiated by real estate prices for urban residential space, which are 40 to 200 percent higher than in traditional suburban neighborhoods -- this price variation can be found both in cities and small communities equipped with walkable infrastructure, he said.

The result is an oversupply of depreciating suburban housing and a pent-up demand for walkable urban space, which is unlikely to be met for a number of years. That's mainly, according to Leinberger, because the built environment changes very slowly; and also because governmental policies and zoning laws are largely prohibitive to the construction of complicated high-density developments.

But as the market catches up to the demand for more mixed use communities, the United States could see a notable structural transformation in the way its population lives -- Arthur C. Nelson, director of Virginia Tech's Metropolitan Institute, estimates, for example, that half of the real-estate development built by 2025 will not have existed in 2000.

Yet Nelson also estimates that in 2025 there will be a surplus of 22 million large-lot homes that will not be left vacant in a suburban wasteland but instead occupied by lower classes who have been driven out of their once affordable inner-city apartments and houses.The so-called McMansion, he said, will become the new multi-family home for the poor.

"What is going to happen is lower and lower-middle income families squeezed out of downtown and glamorous suburban locations are going to be pushed economically into these McMansions at the suburban fringe," said Nelson. "There will probably be 10 people living in one house."

Median home prices dropped 26.7 percent in May across Southern California's six most populous counties compared with last year, a real estate research firm said Monday. DataQuick Information Systems said it marked the steepest annual drop since the firm began keeping records in 1988.

The drop was driven by fewer sales of high-end homes, steeper discounting by home sellers and by lenders trying to unload foreclosed properties, DataQuick said. Median home prices fell to $370,000 in Los Angeles, Orange, San Diego, Riverside, San Bernardino and Ventura counties last month. It was the lowest median price reported since March 2004.

Sales volumes for the region climbed about 8 percent from April but were down nearly 15 percent from May 2007.In all, 16,917 new and preowned homes were sold in May, down from 19,874 in the same month last year, the firm said.

Nearly 38 percent of all the homes sold in the region last month were in foreclosure at some point over the past 12 months.

Rising gas prices may be the latest ailment afflicting the housing market, as figures released Monday showed Southern California home prices plunging 27% in May from a year ago and falling even more precipitously in distant suburbs.

Outlying areas like the Antelope Valley and the Inland Empire have long appealed to people who were willing to accept a burdensome commute for the chance to own a better house. But buyers are increasingly factoring gasoline costs into their purchase decisions, said Dan Griffith, a Rancho Cucamonga-based real estate agent.

"It seems like the money they can save in housing is being absorbed by higher gas costs, so they are a little reticent to commit," Griffith said. "Gas is definitely beginning to be a concern." The median home sale price in six Southern California counties sank to $370,000 in May, down from $505,000 a year earlier, according to DataQuick Information Systems.

DataQuick said that was the biggest annual decline it has recorded since it began tracking prices in 1988. The last time the median was lower was in March 2004, when it was $364,000. Price drops were especially steep in far-flung suburbs. The median price fell 38% in Lancaster and 42% in Palmdale, compared with 23% in Los Angeles County overall.

San Bernardino County saw prices drop by 31%, but it was worse in the remote town of Victorville, where values declined 43%. Christopher Leinberger of the Brookings Institution, a Washington think tank, says home values in these so-called exurbs may continue to languish long after urban markets begin to recover, thanks to higher gas costs.

"Under the old model we have lived with for the past 50 years, you could drive away from major employment concentrations until you could qualify for a house because cheap energy costs made it possible," Leinberger said. "Now as energy prices go up, the housing prices out there on the fringe take a major hit."

Of all the Southern California homes that were resold in May, 37% had been in foreclosure at some point in the prior 12 months, DataQuick said. Gas prices, however, could even be playing a role in foreclosures, according to real estate agent C.J. Johnson in Tehachapi.

"If someone has to decide between putting gas in the car to get to work and feed their family or [making] the house payment, believe me the house payment is not going to get paid," she said. Johnson said most people were better off buying a home within an easy commute of work. Gas is not tax-deductible, she pointed out, but mortgage interest is.

Robert Haywood, 40, says he has seen firsthand the effect of rising gas prices. He commutes from his Lancaster home to his job as a warehouseman in Santa Clarita in a 2001 GMC Yukon, which he says gets about 16 miles to the gallon. Haywood estimates he is spending $400 more a month on gas than he did a couple of years ago. He plans to sell his Yukon and get a smaller car with better fuel economy.

"I cannot buy myself anything," he said. "I can't buy that new barbecue grill or other little things that might keep the economy going." The steady decline in home prices over most of the last year, meanwhile, appears to be luring bargain hunters into markets where values have fallen the most, DataQuick said.

In Riverside County, for example, home values tumbled 28.6% from May 2007 to May 2008, DataQuick said. But the volume of home sales in May of this year actually increased by 4.1% from a year earlier, to 3,444. "One can argue that the stage is being set for a bottoming-out in home sales volume in many areas because prices are coming down sharply enough to attract buyers and home builders have stopped adding new supply," said DataQuick analyst Andrew LePage.

But economist Christopher Thornberg of Beacon Economics thinks home values must fall even lower to come in line with what people can afford to pay.

Last night the annualised UK consumer price index was announced to have reached 3.3%, up from 3.0% in just a month. This is the highest level since comparable records began being kept in 1997 and well above the Bank of England's 2.0% comfort zone limit. But instead of rallying on the possibility of a forthcoming rate hike, the pound actually fell against the US dollar.

Before the global credit crisis began, the UK cash rate was 5.5%. The US rate was 5.25% and the European rate 4%. Australia - which had been dealing with long term economic strength - had a cash rate of 6.25%. In contrast to Australia, the US economy was only moderate at best while the UK and European economies were more or less coming out of the doldrums. A year later the US Federal Reserve has cut its cash rate six times to 2%. The Bank of England has cut twice to 5%.

The European Central Bank has remained fixed at 4% and Australia has seen four rate rises to 7.25%. One year ago the oil price was US$70/bbl and it is now almost twice that. Of the four regions, Australia's is the only one to not see its banking sector decimated by the credit crunch, although there have been some notable casualties. At the same time, as an exporter of commodities Australia has seen its economic growth hold up well. This means the Reserve Bank of Australia has been able to fight inflation by rasing its cash rate. The RBA desperately wants to slow the Australian economy.

The credit crisis had its roots in the US housing market, and the collapse of that market has ushered a sharp slowdown in the US economy, perhaps a recession. As the US economy is by far the largest in the world, under normal circumstances one would expect global inflation pressures to ease as a result. However, with China and other developing nations now in the mix, this is seemingly not the case.

The Fed was quick to respond to the credit crisis by slashing its cash rate, concentrating solely on preventing a collapse of the US banking system and a collapse of the US economy. The US dollar has collapsed as a result, which has made it hard to continue assuming inflation would look after itself. The falling dollar has helped to push up the oil price.

The UK has also been a victim of the credit crisis, most notably in the collapse of Northern Rock. While initially choosing to hold the cash rate steady so as not to be seen to "bail out" greedy investment banks, the BoE was forced to capitulate and make, ultimately, two cuts. But while Europe has also suffered a similar fate in its banking sector, the ECB has held fast at 4%, all the time arguing the risk of increasing inflation.

The ECB has been proven correct, and has now made assertions to suggest that a rate hike in July is well and truly on the cards. However, how much of the ECB's stoicism is actually part of the problem? By not cutting its rate along with its counterparts across the Channel and the Atlantic, the ECB has ensured the demise of the US dollar.

As the greenback has fallen, the oil price has risen, encouraging a massive global shift of funds out of traditional bonds and equities and into direct commodity investment. While this is so-called "speculation" - a bet on higher prices - it is also simply an inflation hedge against the diminishing value of the world's unsecured paper money system. The whole equation has fed on itself.

The problem with the EMU, and the wider trading conglomerate of the European Union, is that the initial well-intended concept of creating a unified and thus more powerful trading bloc is now threatening to unravel. It is a simple case of the disparities between the economic powerhouses such as Germany and France and the vulnerable economies of Italy, Spain, and the states of Eastern Europe. Morgan Stanley is not predicting the break-up of the EMU but suggests something has to give. If Trichet raises the cash rate, another "catastrophic" event could be triggered, the analysts suggest.

Problems arising within the group of EMU nations would not have arisen had the euro not existed, suggests Morgan Stanley. There are extreme current account deficits being run in Spain (10.5% of GDP), Portugal (10.5%) and Greece (14%). In the meantime, Germany has a huge current account surplus of 7.7%. And the imbalances are only getting worse.

European inflation is running at 3.7%, yet in Spain the level is 4.7%. This might serve as a warning to the Bank of England, as Spain is currently undergoing a property price collapse. Credit growth in the emerging Eastern European economies has been roaring along at 40% to 50% a year, and current account deficits have reached 23% in Latvia and 22% in Bulgaria. These are not EMU members, but they do peg their own currencies to the euro. Nor are Hungary or Romania members, but both hold more than 55% of household debt in either euros or Swiss francs.

The bulk of credit growth in Eastern Europe has been provided by banks in EMU member states Austria, Italy and Greece, and by EU member Sweden. If Eastern Europe implodes - and Eastern Europe is suffering the ravages of runaway inflation like every other developing region - then it will take down EMU members with it, leaving the likes of Germany holding the can. What benefit is Germany deriving from the euro?

If the world ever needed a sudden pullback in oil and food prices, the time is now. But as each day goes past, this is failing to happen.

26 comments:

Concerning the price of housing relative to pay. I understand that, but..

A recent news article discussed a "change" in how housing was priced. The banks really own most of the housing. They have shown great reluctance to lower the pricing. The reasons for this evident from this blog.

The banks are ending up with the housing and "they" are setting the prices. The article said this was a change. The market is not setting the prices, the banks are.

This could mean something more ominous. As ownership becomes almost impossible, the banks could hold the property and you lease/rent it. Purchasing is not an option.

Or they tear it down, put the people in shacks and you work the land.

"Governments" role via taxation will also play a great part in how this plays out.

Ownership may be not possible going forward into the future.

However I have learned that the world is a "stage" and the next chapters have yet to be written, and the best laid plans of mice and men often go awry.

"Ultimately, the bank expects the oil price spike to subside as the more powerful force of debt deflation takes hold next year."

This is a likely scenario, perhaps the most likely. What is key are 3 factors: (1) how bad the downturn is going to be, (2) to what extent the downturn affects capital invested in oil production, and (3) how much production comes offline as the world economy shrivels.

#3 is the tricky one. Some new production simply isn't profitable if oil declines below a certain amount. Also, increasing political instability will exacerbate above-ground production factors. Saudi Arabia is particularly vulnerable. Per Capita income has plummeted in the KSA recently. One recent analysis suggested the KSA needs $100/bbl oil just to balance its budget, given all the welfare programs it runs now to keep the minority Shiite population content.

I'm convinced production will decline next year, and so will demand. It is a race between the two to see which will predominate.

I believe that we are seeing two (somewhat related) types of falling demand for petroleum: (1) Forced energy conservation as importers bid for declining oil exports and (2) Declining demand due to less economic activity.

It is a horserace between the two, but the key point to remember is that our model, recent case histories, two years of EIA data, and very recent data from places like Venezuela, Mexico and Russia show an overall accelerating net export decline rate.

Saudi Arabia has shown what I believe will be a temporary rebound in production, but their consumption is increasing like crazy. I expect that at the end of 2008 they will have shown three straight years of production below their 2005 annual rate, at about the same stage of depletion at which the prior swing producer, Texas, started declining.

Regarding the US economy, my analogy: The US economy is like a guy with terminal cancer and a severe heart condition, who was shot as he was run down by an 18 wheeler. What killed him? Does it really matter?

Stoneleigh or anyone,I'd like your opinion of whether it would be best to do preparations such as solar hot water, PV's, additional insulation, household appliance changes, etc. before or after this economic downturn hits. I suspect many businesses will be going bust. On the one hand, one could save money after deflation hits. On the other hand, if too many systems have broken down the chances of getting these things installed could be iffy. Thanks for your reply(s). (That first article--YIKES. When this hits MSM in the US, its history folks.)

I think it was cj ? who recently asked about timing. Now is the time or to borrow a phrase from Obama, " this is the moment", " this is our moment". Whatever get on with the preparations. I spent some hours to-day warning friends and family again. I sent them the Telegraph article. This was my last call out so to speak. I'm busy now getting my affairs in order.

I'm glad to see a bunch of people picked up on the message of that first article by Evans-Pritchard.

If and when a credit strategist for one of the world's largest banks says that clients need "to brace for a full-fledged crash in global stock and credit markets over the next three months", I'd say it's time to pay attention.

We have of course said the same thing at this site for a long time, but when these folks say it, it comes from a -financially- far more involved point of view. There are multi-billions of dollars listening in now.

That it follows to state: "...as inflation paralyses the major central banks" is of course silliness, and a shame too. We will have to live with faulty definitions of inflation, even if that is not at all unimportant.

The point is that it makes people incapable of recognizing true inflation, such as it happens these days in China, a phenomenon completely different from what we see in North America.

Remember these words, they come from a leading bank's strategist: "A very nasty period is soon to be upon us - be prepared."

The banks are not setting home prices. They wish. They can't afford to hold all that property in their books. The homes will still have to be sold at some point, and who will then have the money to buy them? Other banks?

Oil and and its scarcity, pricing and investment policies play but a minor role so far in global economics. That role will increase in the years to come, but for now it's credit policy and its influence on housing and monetary markets that play the lead.

Gas prices grab headlines simply because they are an everyday issue, and almost nobody is equipped to understand that it makes no sense to complain about a $1 per gallon rise in pump prices while their homes lose $1000 per week in value.

But, whether they see it or not, that is what happens. Don't be played by the media.

I would say execute your preparations as soon as possible, while you still can. There is no guarantee out there that any of what you want will become cheaper, let alone more easily accessible and/or available in the future.

I think I have been in shock all day with the realization that is it "SHOW TIME !", not an audition, not a rehearsal... My response to the shock is to focus on a minute detail of the horror. In my case, I have been obsessing about a detail in the Depression photos. Nobody is wearing any shoes! Dirty feet! Yuk! Its one thing to walk the earth, the fields, the woods, country roads and ditches! Imagining myself barefoot in this " cement jungle" is , well, just not sustainable. Jeez, I'd better get a grip!

Anon- "I would say execute your preparations as soon as possible, while you still can. There is no guarantee ..."

I agree. not only availability could be a problem; but people could suddenly start scrambling for desirable stuff- and make it hard to get. We know what we can do today- tomorrow is looking like a crapshoot.

that's for you ilargi I would have linked Mr Tambourine Man but It was nearly supper time and on an empty stomach I couldn't handle a young fuzzy bunny looking Bob Dylan, but since then I have eaten and hope you and everyone else has too.

Incidentally, at the time of the Wesley Harding album Bob was going on about Globalization of the economy. He said he didn't think it a very good idea which at the time seemed a strange sound to my ear, but here we are all globalized economized and fit to be tied.

There are the two "brothers" that guard each pole of the earth, and one day they will unite.

The Hopi have "the one true white brother", but there is more to it than that, he will have a "helper".

the best advice a friend once gave me

"don't worry be Hopi".

The Hopi are amazing human beings in my opinion. I hold great respect for those on the mesa's. It is my shared belief system with them that I see the climate change as part of a cycle. The Hopi have spoken of a Time of the Purification. They believe it is happening now, and I share that belief, and that is why the earth is shaking, and volcano's and all the unrest of the white man and the other three colors of men. REd Black and yellow

Did you know that if you could push and rod thru the earth from Hopi land it would come out in Tibet. That the Hopi and the Tibetan words for hate and love and sun moon are opposites and there are other interesting similarities between these two cultures.

"I looked, and there before me was a pale horse! It's rider was named Death, and Hades was following close behind him. They were given power over a fourth of the earth to kill by sword, famine, and plague, and by the wild beasts of the earth."

Hmmm, sound sorta like the two brothers, of course any comparison between Christian bible prophecy interpretation passed down mouth to ear for centuries from Native American is just a coincidence ;)

Dark Matter, have you ever seen an image or replication of what is called Prophecy Rock on the Hopi Reservation..

I know many of you are atheist here, and those that post on the oildrum, maybe Il and LS, your choice, and that is what its all about. Right or wrong probably depends on which side you choose. Or does it. I'm not a preacher, more of a teacher.

Ilargi and Stoneleigh, Just been reading the announcement that the UK elected gov't is handing new powers to the Bk of England.The press release says that the Bank, not the gov't, is now responsible for managing the economy. Is there not something amiss here when the elected by the people hand over control to the unelected appointees. England's central bank has been trading taxpayer's money for " not marked to market paper" a la Fed.Is Brown's gov't admitting they don't know what the " fcuk" to do, how to manage? Or is this decision one of the final moves in a planned coup?

Ha! Speaking of people not listening I've received some feedback from my call out yesterday. the responses range from pity to ridicule. In summary recipients of my call say, " I'm not worried. Be happy,don't worry." Ilargi, I can relate to how you feel when you have invested so much more. Also appreciate your point about what information is forming policy. Makes sense that it is credit and housing. I get overwhelmed with distressing information from the environment,politics etc. It is useful to identify what is driving policy.

ilargi, it looks like dark_matter has a winner for us in the "what does Dylan mean" contest. Love that runner up of bike mechanic's two brothers, but don't think winds would howl at their approach.

Googled and found this:

The Hopi Prophecy Rock shows ‘two heart men’ as well. This means that we will ultimately learn to think with our hearts (our intuitive, sensitive, feeling side) as well as with our heads (our rational minds).

From the one about the plummeting money supply in the UK, there is a point I don't understand:'The Bank of England says the overall M4 figure - growing at 11.1pc - is distorted by strains in the interbank markets. Once this effect is stripped out, the M4 growth rate is down 16pc a year ago to 4.5pc in the first quarter.'

Can anyone explain to me what these 'strains in the interbank markets' are, and why should the 11.1pc growth in fact be viewed as only 4.5pc growth?

Well Francois, I'd say it appears that Ilargi thinks we are all twits. This is not the first time such name calling has been directed at his own readers and its tiresome. I've already started to look elsewhere for economic news and more name calling of the very people reading this blog is only going to encourage that process.

Ilargi, I don't know if that is what you intended but it's what you are accomplishing - starting to drive off the very people who read your material. If that is your goal, you are beginning to succeed.

I doubt it was Ilargi's intention to insult his readers though I know when I am angry about work I sometimes snap at the ones I love best in all the world. Even if the intent was to call me a twit (I hope I am at least an upperclass twit :) I will continue to read this blog. I'll take the truth however I can get it.